Loss & Policy Reserves
The Tax Cuts and Jobs Act (TCJA) made significant changes to the calculation of property/casualty (P&C) and life reserves for tax purposes. For example, P&C reserves must be discounted using IRS-published factors, and the opening tax reserve adjustment as of January 1, 2018, must be brought into income over the eight-year period from 2018 to 2025. Proposed factors were published in January 2019 (Rev. Proc. 2019-06). However, revised factors were released in July 2019 (Rev. Proc. 2019-31) and additional guidance was issued to address the change in accounting method from adopting these new rules (Rev. Proc. 2019-30). The IRS also issued Rev. Proc. 2019-34, which addresses accounting method changes resulting from TCJA amendments to life insurance company provisions. This additional guidance provided the following clarifications:
- Companies using the proposed factors on their 2018 tax returns can either amend those returns using the revised factors or calculate a separate “Remainder Adjustment” to be included over the remaining seven-year period (2019 to 2025).
- Taxpayers taking the latter approach should include an additional “Supplemental Adjustment” to help avoid double counting; this Supplemental Adjustment should be included over one or seven years at the taxpayer’s discretion.
- The salvage and subrogation (S&S) TCJA adjustment should be included based on the traditional Section 481 inclusion rules—one year for a tax deduction and four years for an item of taxable income.
- Similar rules are adopted for taxpayers who employed the proposed factors to discount S&S and don’t plan to amend their 2018 tax returns.
- Changes to §807(c)(3) reserves (life and annuity reserves not involving life, accident or health contingencies) caused by the TCJA should be included based on the traditional §481 inclusion rules—one year for a tax deduction and four years for an item of taxable income.
Note that the statutorily mandated transition periods should be used to determine reversal patterns for deferred tax asset (DTA) admissibility.
P&C companies retained their net operating loss (NOL) carryback rules. Thus, 2019 is the last year P&C companies can carry back NOLs to 2017, a higher tax rate year. P&C companies that are anticipating a 2019 NOL or that have small amounts of income should consider additional planning opportunities to carry back NOLs to a 35 percent tax rate year. For example, bonus depreciation and §179 expensing are two administratively simple ways to reduce income or enhance losses.
Note that the capital loss carryback rules for P&C and life companies remain intact. Net capital losses generated in 2019 and 2020 can be carried back to 2016 and 2017 (high tax rate) years.
Life Company NOL Carryforwards
Life company NOLs can’t be carried back but can be carried forward indefinitely. This makes paragraph 11.a. of SSAP 101 moot for life companies, as there’s no carryback available under the law. Furthermore, life company NOL carryforwards can only offset 80 percent of taxable income in any given year. This adds complexity to the 11.b. admissibility test.
Consider the following fact pattern: Celebrate Life Insurance Company (Celebrate) has a deductible temporary difference (DTD) of $3,000, resulting in a DTA of $630 as of December 31, 2019. Celebrate also projects taxable income without the reversal of the $3,000 DTD of $1,000 in each of the upcoming three years—2020, 2021 and 2022. Let’s assume the DTD is projected to reverse entirely in 2020. All taxable income in 2020 would be absorbed, resulting in a $210 admitted DTA and a NOL carryforward of $2,000. However, the 80 percent NOL offset limitation would come into play in 2021 and 2022. Only $800 of taxable income in each of these years can be offset for an admitted asset of $168 in each of 2021 and 2022. Of the $630 gross DTA, only $546 would be admitted, with $84 nonadmitted.
Now let’s alter the fact pattern and assume the DTD is projected to reverse in 2022. All taxable income in 2022 would be absorbed, resulting in a $210 admitted DTA and a $2,000 NOL. However, the NOL can’t be carried back, and any carryforward would extend beyond the three-year window under 11.b. of the admissibility test. Consequently, only $210 of the $630 DTA would be admitted, with $420 nonadmitted.
Valuation Allowances & DTL Scheduling
Before statutory filers address DTA admissibility, they must determine the DTAs will “more likely than not” be realized. With a less restrictive time period than the three years provided by SSAP 101, does the company believe it’s more than 50 percent likely that its tax deductions and carryforwards will reduce future taxes?
There are four sources of income to be considered:
- Reversing taxable temporary differences
- Future taxable income
- Recoverable taxes in the carryback period
- Tax planning strategies
It’s important for companies to document their valuation allowance analysis and conclusions. Although each source of income can be considered, using reversing taxable temporary differences (which give rise to DTLs) can create complexity in paragraph 11.c. of the admissibility test. Revised Q&A paragraphs 2.7 and 4.13 clarify that companies aren’t required to schedule DTL reversals if taxable temporary differences aren’t considered as a source of income in asserting that a valuation allowance isn’t required. Consequently, it behooves companies to consider the other three sources of income first. If those sources are sufficient to meet the more-likely-than-not standard, companies should document accordingly and perform the 11.c. DTA/DTL admissibility test without scheduling. It’s worth noting that character (ordinary versus capital) must still be considered in paragraph 11.c.
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